通用磨坊 (GIS) 2017 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the quarter two FY17 earnings conference call.

(Operator Instructions)

As a reminder, today's call is being recorded Tuesday, December 20, 2016.

Now I'd like to turn the conference over to Jeff Siemon, Financial Director of Investor Relations.

Please go right ahead, sir.

Thanks, Tony.

Good morning and happy holidays to everybody.

I'm here with Ken Powell, our CEO; Don Mulligan, our CFO; and Jeff Harmening, our President and COO.

I'll turn you over to them in a minute, but first I'll cover our usual housekeeping items.

Our press release on second-quarter results was issued over the wire services earlier this morning.

You can find the release and a copy of the slides that supplement this morning's remarks on our Investor Relations web site.

And I'll remind you that our remarks this morning will include forward-looking statements that are based on management's current views and assumptions.

The second slide in today's presentation was factors that could cause our future results to be different than our current estimates.

With that, I'll turn you over to my colleagues, beginning with Ken.

All right, well, thanks, Jeff, and good morning to one and all.

I'll cover the key headlines for the second quarter.

First, we feel good about the margin expansion progress and EPS growth we delivered in the quarter, and we continue to have confidence in our ability to deliver on our goal of a 20% operating margin by FY18.

We remain committed to our Consumer First strategy.

And where we're getting the ideas right, it's driving growth, whether that's Annie's and Larabar in the US, Haagen-Dazs outside North America, or Old El Paso around the world.

Even so, our net sales performance did not meet our expectations in the second quarter.

We didn't have enough marketing support, meaning the combination of the trade, media, and new product news, to drive improved top-line results.

And on top of that, we saw a slowdown in food industry growth in the US in recent periods.

So we're making targeted adjustments to our plans in the back half to find the right balance of investment and return, while still driving significant margin expansion.

Jeff Harmening will take you through more details on our second-half business plans in a moment.

As a result of our sales trend, we're revising down our expectations for full-year net sales and segment operating profit, but we remain on track to deliver our EPS and margin expansion guidance.

And we're increasing our free cash flow growth expectations thanks to continued good financial discipline.

Finally, we announced an important change to our organizational structure earlier this month.

This change represents a significant step towards operating as a global Company, allowing us to unlock global growth opportunities while continuing to drive efficiency and increase agility in our organization.

So with that, let me turn things over to Don to provide more detail on our financial performance.

Thanks, Ken, and good morning to everyone.

With that as a backdrop, let me get into the numbers, provide a summary of our cost savings efforts, and give you some more details on our updated guidance.

Slide 6 summarizes our second-quarter FY17 financial results.

Net sales totaled $4.1 billion, down 7% as reported.

Organic net sales declined 4%.

Total segment operating profit totaled $830 million, comparable to last year on a constant currency basis.

Net earnings decreased 9% to $482 million, and diluted earnings per share were $0.80, as reported.

Adjusted diluted EPS, which excludes certain items affecting comparability, was $0.85.

Constant currency adjusted diluted EPS increased 5% compared to last year's results.

Slide 7 shows the components of total Company net sales growth.

Organic net sales declined 4% in the quarter, driven by 7 points of lower organic pound volume growth, partially offset by 3 points of positive sales mix and net price realization.

Foreign currency translation didn't have a material impact on net sales this quarter, and the net impact of acquisition and divestitures reduced sales growth by 3 points in the quarter.

Turning to segment results, total US retail net sales declined 9%, with growth in snacks offset by declines in the other operating units.

Organic net sales were down 6% in the quarter.

The difference between reported and organic net sales primarily reflects the divestiture of Green Giant, which impacts the meals unit results.

Segment operating profit grew 2% versus last year, with benefits from our margin expansion initiatives more than offsetting lower volumes.

In our Convenience Stores and Foodservice segment, net sales declined 4% in the second quarter.

This segment's focus six platforms returned to growth, with net sales up 2%, driven by growth in cereal, yogurt, snacks, mixes, and biscuits.

As we expected, net sales declined 10% on our non-focus six businesses in the quarter, primarily due to market index pricing on bakery flour.

We expect headwinds from flour index pricing, which impact sales with a profit neutral to lessen significantly in the second half.

For the second quarter, segment operating profit was up 6%, driven by benefit from cost-savings initiatives, lower input cost, favorable product mix, and higher grain merchandising earnings.

Slide 10 summarizes our constant currency net sales and profit results for our international segment.

Total international organic net sales declined 1% in the second quarter.

At the region level, second-quarter constant currency net sales in Asia-Pacific region were comparable to last year, with double-digit growth in India, offset by the restructuring of our Snacks business in China, which we announced last quarter.

This action will continue to be a headwind to sales growth through the first quarter of FY18.

Excluding Snacks, net sales for the rest of our China business were up mid single digits in the quarter.

Latin America sales declined 2% in constant currency in the second quarter, reflecting the net impact of acquisitions and divestitures.

Organic net sales in the region were up low single digits.

In Europe, constant currency net sales were down 3%, with declines in yogurt offsetting growth for Haagen-Dazs and Old El Paso.

In Canada, sales were down 7% in constant currency, almost entirely due to the divestiture of Green Giant.

Constant currency international operating profit declined 18% in the quarter due to currency-driven inflation on products imported into Canada and the UK.

While we expect further headwinds from the British pound in the second half, the Canadian dollar impact should moderate significantly.

Turning to joint venture results on Slide 11, CPW net sales grew 3% in constant currency, with broad growth across the Middle East, Asia, the UK, and Australia.

Haagen-Dazs Japan constant currency net sales increased 21% due to strong new seasonal product performance and double-digit growth in handheld treats.

Combined after-tax earnings from joint ventures totaled $30 million in the second quarter, up 27% in constant currency, primarily driven by strong sales growth, as well as lower administrative costs for CPW, and lower input cost for Haagen-Dazs Japan.

As Ken said, we made good progress on our margin-expansion goals in the second quarter.

Adjusted gross margins were up 130 basis points, with benefits from holistic margin management and our other cost-savings initiatives more than offsetting low input cost inflation.

For the full year, we continue to expect cost of goods sold HMM savings to more than offset our expectation of 2% inflation.

Adjusted operating profit margins increased 160 basis points in the quarter, slightly ahead of our full-year goal.

Slide 13 summarizes other noteworthy income statement items in the quarter.

We incurred $53 million in restructuring and project-related charges in the quarter, including $24 million reported in cost of sales.

Corporate unallocated expenses, excluding certain items affecting comparability decreased $18 million.

Net interest expense increased 2% from the prior year.

We continue to expect full-year interest expense will be flat to last year.

The effective tax rate for the quarter was 32.8%, as reported.

Excluding items affecting comparability, the tax rate was 32.4% compared to 32.3% last year.

We now expect our full-year tax rate will be roughly in line with the year-ago rate of 29.8%.

And average diluted shares outstanding declined 2% in the quarter.

We now expect a 2% reduction for the full year compared to our previous guidance of down 1% to 2%.

Turning to our first-half financial performance.

Net sales of $8 billion were down 7% as reported and down 4% on an organic basis.

Segment operating profit declined 2% in constant currency, and adjusted diluted EPS was up 1% as reported and up 2% in constant currency.

Turning to the balance sheet, slide 15 shows our further progress on core working capital.

Our core working capital decreased 20% versus a year ago, and we continue to drive operational improvements across our business.

This is the 15th consecutive quarter that we reduced core working capital.

And we have visibility to further reductions in the coming quarters [buying] continued efforts to improvements in payables.

As a result, we're raising our FY17 guidance on free cash flow growth from mid-single digits to high single digits.

First-half operating cash flow was $988 million, down 15% from a year ago, largely driven by timing of trade and advertising accruals and taxes payable related to the Green Giant divestiture last year.

Year-to-date capital investments totaled $318 million, and through the first half of the year, we returned $1.8 billion to shareholders through dividends and net share repurchases.

As Ken mentioned, we're taking another step toward operating as a global Company by changing our reporting structure to maximize our global scale, unlock global growth opportunities, and continue to drive efficiency.

We've established four new business groups: North America retail, which combines our current US retail segment and our Canada region in our international segment; Europe and Australia, which is currently another international region; Asia and Latin America, which combines the remaining two current international regions; and Convenience Stores and Foodservice.

As part of this change, we anticipate eliminating 400 to 600 positions worldwide, which we estimate will drive savings of $70 million to $90 million by FY18.

We intend to begin reporting results under this new structure in the third quarter and will provide restated historical data at that time.

This announcement is the latest in a series of significant actions we've taken since FY15 to streamline our structure and drive savings.

As always, HMM is at the center of this effort and continues to deliver significant savings in our cost of goods.

In fact, between FY15 and FY17, HMM will generate more than $1.2 billion in cost-of-goods-sold savings, which keeps us on track to achieve our target of $4 billion of savings from HMM this decade.

We've announced additional projects since FY15 to improve our organizational effectiveness while delivering incremental cost savings.

As part of our initiative to streamline our global supply chain network, we will have closed 11 plants by FY18, or 17% of our 2014 factory base.

Including those plant closures, as well as Project Catalyst, Compass, and our new global reorganization, we'll have reduced approximately 5,000 positions by FY18, or roughly 12% of our global headcount.

And we continue to reduce our administrative expenses and drive incremental savings through our implementation of zero-based budgeting.

We estimate these projects will drive $700 million in aggregate cost savings by FY18, above and beyond HMM.

We're progressing well on our goal to 20% adjusted operating profit margins by FY18, which represents more than 300 basis points improvement over FY16 levels.

We continue to expect this margin expansion to come from three areas.

First, our FY17 COGS HMM savings, net of inflation, still makes up about 25% of our goal.

At our Investor Day in July, we said the other two buckets were split roughly equally.

Now that we provided visibility to our global reorganization, you can see that savings from our announced projects represent fully half of our margin expansion goal.

The remaining 25% will come primarily from strategic revenue management, spending optimization efforts, and other cost-efficiency initiatives.

So let me finish with our second-half expectations and full-year outlook.

We expect modest improvement in organic net sales growth in the second half, as we adjust our levels of support and continue to invest in Consumer First news that is working.

We expect to deliver significant adjusted operating profit margin expansion thanks to our cost-savings efforts, and that in turn will help drive double-digit growth in adjusted diluted EPS in the second half.

Finally, we expect to accelerate our free-cash-flow growth behind further improvements in our core working capital.

I'll close my section by summarizing our updated FY17 guidance, which you can find on Slide 21.

Given our first-half performance, we now expect full-year organic net sales to be down 3% to 4%.

As a result, we're now targeting total segment operating profit growth of 2% to 4% on a constant currency basis versus the prior guidance of 6% to 8% growth.

We continue to expect adjusted operating profit margin expansion of 150 basis points.

As I mentioned previously, we expect interest expense and our adjusted tax rate will be flat to last year, and we anticipate average diluted shares will decline 2%.

We continue to expect adjusted diluted EPS will be up between 6% and 8% in constant currency.

We now expect foreign currency translation will be a $0.01 headwind to full-year diluted EPS results.

Finally, we're increasing our free-cash-flow guidance for mid-single-digit growth to high single-digit growth, reflecting continued strong core working capital discipline.

And with that, I'll turn it over to Jeff.

Thanks, Don and good morning, everyone.

As Don mentioned, we posted organic net sales declines in the quarter, with our growth in foundation businesses down 3% and 8%, respectively.

In some businesses, we met our expectations, and in others, we fell short.

We didn't deliver the top-line improvement we were expecting from the US retail in the second quarter, with organic sales finishing down 6%.

On the other hand, margin delivery was strong, with US retail operating profit margins up 270 basis points to 24.4%.

We also expected better net sales performance for our Convenience Stores and Foodservice segment, and we met that expectation, with our focus six platforms returning to growth this quarter.

Within our international segment, we expected improved organic net sales performance.

We saw top-line improvement in Europe and in China offset by a slowdown in Canada, leaving the total segment organic net sales growth in line with our first-quarter results.

Let me describe in more detail the drivers of our second-quarter performance and discuss our operating plans for the second half this year, starting with US retail.

The operating environment here in the US remains challenging.

As you can see on Slide 24, the industry has experienced a slowdown in retail sales growth, including a decline in the most recent quarter, as benefits from pricing have eroded and unit volume has remained weak.

In our categories, average unit prices were up 3% last quarter but volume softness drove overall category retail sales down 1%.

For our business, it was our five largest categories, cereal, yogurt, snack bars, refrigerated dough, and soup that fell short of expectations.

As Ken told you up front, we did not have enough marketing support in the form of trade and consumer spending and new product news to deliver the improvement we were looking for.

We also saw a bit more competitive activity in some of these categories in the quarter.

In our other categories, our results were actually a bit better than our expectations, led by Old El Paso Mexican foods, Totino's hot snacks, and our natural and organic portfolio.

We're adding back some support in the second half, but we will remain disciplined in our spending.

We still believe prioritized investment against the best growth opportunities, while continuing to drive margin expansion, is the right thing to do for the long-term health of our business.

Retail sales for our cereal brands were down 3% in the quarter.

Where we had compelling Consumer First messaging, we saw good consumer response.

For example, our gluten-free Cheerios news and removal of artificial ingredients continues to drive growth in baseline or full-price sales, and consumers still love great tasting cereals.

More cocoa in Cocoa Puffs are driving double-digit retail sales growth for this brand, and more cinnamon news continued to drive good performance on Cinnamon Toast Crunch.

But overall, we didn't get the quality of merchandising we expected, and we didn't have enough marketing pressure to drive better results for our business in the quarter.

In the second half, we're adding incremental consumer spending to support news that's working, like gluten-free Cheerios and the removal of artificial ingredients.

We'll also improve our in-store execution, and we're securing better merchandising events with key retailers on some of our largest established brands.

In total, we expect to continue to drive positive net price realization for our cereal business in the back half of the year.

New products will also contribute to improved second-half performance.

We're bringing the taste of real fruit to Cheerios, with a new Very Berry variety.

It contains strawberries, blueberries, and raspberries, with no artificial colors or flavors, and, of course, it's gluten free.

Watch for it in the stores beginning next month.

On yogurt, we continue to see challenging performance in the second quarter, with retail sales down 18% and our Light and Greek 100 varieties driving the majority of those declines.

Retail sales for the yogurt category also turned negative in quarter, as elevated levels of merchandising generated less incremental lift and as the level of new products news slowed.

On a more positive note, we're seeing good initial consumer response to our Annie's and Liberte organic yogurts that we launched in the first quarter.

As we enter the second half, we'll build on our first-half yogurt news.

Together, the Annie's and Liberte brands already hold an 8% share of the organic yogurt segment.

We expect these brands to have a more significant impact on our second-half performance as we continue to expand distribution.

We also renovated our Go-Gurt offerings in the first half, improving the value proposition with larger counts of individual tubes.

Where we're getting the price right with retailers, it is performing quite well, so we'll look to expand that success in the remainder of the year.

We're also introducing new and renovated yogurt offerings in the second half that squarely meet consumer needs.

Our renovated Greek 100 protein line appeals to consumers looking for a higher amount of protein for just 100 calories.

It's made with real fruit and has the delicious, thick texture that we think consumers will prefer.

Yoplait Dippers combine creamy Greek yogurt with the crunch of pretzels or oat bites.

They offer spoon-free snacking and are a perfect afternoon pick-me-up.

And Yoplait Custard Yogurt is a silky smooth indulgent snack or dessert made with whole milk and just a few other simple ingredients.

We know we have a good deal to of work to do to turnaround our yogurt business.

We expect some improvement in the second half, but won't return to growth this year.

We believe the key to success will be fundamentally shifting our portfolio through renovation and innovation to give consumers what they want from their yogurt; that's the essence of Consumer First.

The product news I just shared will help us make important strides toward that goal in the second half of this year.

And we have a great pipeline of innovation, including an exciting launch in early FY18 that should help build a strong foundation for the future.

On snack bars, Nature Valley retail sales were down 3% in the second quarter, so we're adding some incremental media support in the back half and we have a good line up of new launches.

We're expanding our successful biscuit sandwiches with a Cocoa Almond Butter variety; we're launching new XL Sweet & Salty bars that are 50% bigger, developed with men in mind; and we're very excited about our new Granola Cups, which feature a crunchy, whole-grain shell filled with peanut or almond butter.

They add an indulgent offering to the Nature Valley brand, but with just nine grams of sugar per serving.

Retail sales for Fiber One bars were down double digits in the second quarter, consistent with the decline in the adult segment of the bars category.

As you may recall, Fiber One was the first brand to do the seemingly impossible, make fiber taste good.

And we're making it taste even better with new layered bars that contain crisp grains, caramel, and almond toppings and chocolate, and nine grams of fiber per bar.

On Larabar, retail sales were up more than 50% in the second quarter.

In the back half, we're expanding Larabar's offering with a line of new fruits and grains bars.

Each bar contains a quarter cup of kale or spinach, giving Larabar consumers the nutrition they're looking for in just five simple ingredients per bar.

Refrigerated dough and soup round out our largest five categories in the US, and we're supporting these businesses with consumer news in the second half.

We'll be adding marketing support to Pillsbury refrigerated dough and we have news coming for Easter too.

And with our new shelf set of stand-up cans, we continue to expand across retailers.

Our performance on Progresso soup wasn't where we want it to be in the second quarter, as we experienced heightened competitive activity and unusually warm weather.

Well, winter is certainly here now and we're ramping up our messaging behind our antibiotic-free chicken news.

As I mentioned earlier, we saw good results in our other categories in US the retail and will build on that momentum in the second half.

Old El Paso has been generating growth within our meals platform in recent years.

Consumer First innovation, including new flavors and formats of stand-and-stuff shells and tortillas drove retail sales up 6% in quarter.

Innovation is also working for Totino's hot snacks, with retail sales up 6% in the quarter.

We saw particularly good performance on pizza sticks, which were launched in the first quarter, and we'll introduce larger count sizes next month.

We think this is a great example of knowing our consumer and reaching them with relevant products and messaging.

The Annie's brand continues to lead our growth in natural and organic.

Retail sales for the brand grew 46% in the second quarter and our points of distribution are up more than 30% year-to-date in Nielsen-measured channels alone.

Retail sales for Annie's established items like snacks and mac and cheese grew 20% in the quarter, and we continue to build distribution on our category extensions in cereals, yogurt, soup, baked goods, and grain snacks.

Next month, we'll introduce Annie's organic ready-to-eat popcorn.

With the strength of this great brand, as well as the performance of our other terrific natural and organic brands, we are well on our way to meeting our goal of $1 billion in net sales for our natural and organic portfolio by 2019.

So as we look to the second half, we have plans in place to drive improvement for our US retail businesses.

We're optimizing our marketing support across our five largest categories.

We'll continue to build on what's working by investing behind our natural and organic businesses, as well as Old El Paso and Totino's.

We have a solid line up of new products that are aligned with growing areas of consumer interest, and we'll continue to drive margin expansion for US retail, building on the improvement we posted in the first half.

Let me turn briefly to our Convenience Stores and Foodservice segment.

As Don mentioned, net sales declined in the quarter, driven in large part by negative impact of flour pricing.

However, our focus six platforms posted net sales growth, led by our yogurt platform, with net sales gains for Yoplait Parfait Pro and increased cereal sales in schools.

In the second half, we expect continued good growth from our focus six platforms and a reduced headwind from our flour index pricing.

We'll also bring more innovation to Foodservice customers with new, artisan breads designed for K through12 schools.

This includes pre-sliced, premium quality ciabatta breads and flat panini breads that allow operators to make hot sandwiches with reduced labor and without additional equipment.

In total, these efforts should result in improved top-line performance for this segment in the second half.

Now let's turn to our international segment.

Sales in our developed markets were mixed in the second quarter.

Retail sales for Old El Paso were up high single digits in Canada, behind stand-and-stuff taco shell innovation.

In Europe, we posted high single-digit retail sales declines on yogurt, high single-digit growth for wholesome snacks, and high teens growth for Haagen-Dazs, led by stick bars.

In the second half we'll build on what's working in developed markets and also bring new product news to our categories.

Our Old El Paso stand-and-stuff business has been a good growth driver in recent years, and we recently launched a mini shell variety in Europe.

And we're expanding our successful Haagen-Dazs stick bars into new European markets and adding new flavors to the line.

On yogurt, we're focusing on improving our in-store execution and closing distribution gaps.

We're also entering the fast-growing indulgent segment with our new Triple Sensations line.

In Canada, we're launching Yoplait whole milk yogurt that has all family appeal and will drive growth on our expanding natural and organic business with the addition of items like Larabar Bites.

China is our largest emerging market, and we still have good second-quarter net sales growth there on Haagen-Dazs, Wanchai Ferry, and Yoplait.

Our Yoplait yogurt business continues to grow in Shanghai and we're gaining a foothold in Beijing, which we entered this summer.

As Don mentioned, our results were partially offset by our snacks restructuring in China, which is a headwind of sales but will be slightly accretive to underlying profit.

And in the EMEA region, Haagen-Dazs stick bars launched in the first quarter and are performing well.

In the second half in China, we're launching a new Wanchai Ferry's kids line in time for the Chinese New Year.

These dumplings come in colorful wrappers and are smaller size for kids and have nutritional ingredients like pork, salmon, and shrimp that appeal to moms.

On Haagen-Dazs, we're launching new fruit and flowers ice cream flavors, like rose and raspberry and elderflower and black currant, that deliver a sweet, aromatic experience.

In EMEA, we'll continue to drive growth on Haagen-Dazs, with new flavors of stick bars and our core pint business, and launching frozen yogurt across multiple markets following its success in China.

For our international segment in total, we expect our underlying top-line trend to improve in the back half, and we're planning for operating margin expansion as transaction currency headwinds moderate.

And now, I'll turn it back to Ken for some closing remarks.

All right, so thank you, Jeff.

Let me just summarize our comments this morning.

We continue to take a disciplined approach to the top line, focusing our investments behind our highest return and Consumer First ideas, and eliminating activities that not generating profitable volume.

Our organic sales results didn't meet our expectation this quarter, so we're adding support and launching a solid line up of new products to strengthen the second half.

We delivered strong margin expansion and good EPS growth in the second quarter, and our HMM and other cost-savings efforts keep us on track to deliver our FY18 goal of a 20% adjusted operating profit margin.

And we updated our full-year growth goals to reflect a softer top line, but we're maintaining our EPS guidance and increasing our free-cash-flow growth target as we continue to drive operational efficiency across our businesses.

So that concludes our prepared remarks.

Operator, you can open the line for questions.

Thank you very much.

(Operator Instructions)

We'll get the first question from the line from Robert Moskow with Credit Suisse.

Go right ahead.

Hi, thank you.

Jeff and Ken, I think investors are going to look at this guide-down for sales and segment operating profit as a referendum on the industry's efforts to reduce trade promo, reduce advertising as a means to improve margins and improve efficiency.

And I just want to understand how you're thinking about it internally.

You say you're going to have to add back some marketing in the back half of the year on a selective basis, but can you give us a sense of comfort that the strategy for this year and for next year that you're not cutting too far to the bone or that there's not going to be a bigger reinvestment in 2018 to make up for what's been lost in the first couple of quarters?

Hi, Rob, this is Ken.

I'll start, and I'm sure Jeff will want to jump in.

So we think it's very clear that taking a very disciplined approach to spending, both trade promotion and consumer is the right thing to do.

And quite honestly, we're going through depth and frequency and executional approach across our trade promotion, and we have the ability to look at those and understand their impact almost deal by deal.

And we think that doing that and that approach is the right thing to do.

We just don't want to promote in ways that create a loss for us.

And the same, of course, is true for consumer spending, and we've got to see the return.

So I think we remain very convinced and committed to expecting strong return from our promotional and advertising dollars.

Having said that, as we look back at the first quarter, we think there are cases where we cut too far or reduced spending too much in certain areas.

And so we're going so add back and correct as we go forward in the second half.

And I think you heard Jeff comment on some of the areas where we're going to do that.

So fundamentally, we think discipline in this area is good and there are opportunities to improve, I think quite significantly, but we've got to correct as we go forward into the second half.

Jeff, I don't know if you'd add anything?

I would say importantly in some areas, we reduced our spending in trade.

For example, in Old El Paso and Totino's hot snacks, we got it really right and we increased our revenues partially as a result of that, along with some good innovation.

And so there are areas where we feel really good about what we have done.

And cereal is not far off either, to be honest, and cereal really is a matter of -- we think we've got great ideas.

We just didn't spend enough consumer marketing support against those, which we'll add back.

But fundamentally on the trade side, we didn't get that too wrong.

There are a couple businesses where we didn't get it as right as we want.

I would say Pillsbury refrigerated dough is one of those.

So we're dedicated to the strategy, and we got it right in some places.

And some place we didn't get it exactly right, and we're making the changes that we need to.

Jeff, can I ask a follow-up?

You have one chart that's rather striking that shows category pricing has gone negative for the first time in a long time in US retail, but your price realization is up over 3%.

How sustainable is that?

Well, I think Rob, I think it's a really good question.

If you look at the -- prices have actually deflated if you look at the total store, but it's really driven by the perimeter.

So if you look at the perimeter of the store, that's where you see pretty significant price deflation.

In the categories where we operate, we're actually seeing modest amounts of price inflation.

And so when we think we can generate pricing, we think we generated a touch too much in the second quarter, but we can generate pricing even in this environment because we are -- in the categories that we compete in, we're actually seeing positive price realization.

Okay, that's helpful, thank you.

Thank you very much.

We'll get to our next question on the line from Bryan Spillane with Bank of America.

Go right ahead.

Good morning, everyone.

Hi, Brian.

Just two quick ones.

First one, if we look at the guidance for the full year, could you just give us some color in terms of phasing?

Will more of it be pushed into the fourth quarter in terms of the growth or would we see some improvement in 3Q?

Brian, this is Don.

We expect a bit of sales improvement in Q3 and more in Q4.

Obviously our cost savings build, cost-savings initiatives build as the year goes on.

So as a result of that, the EPS growth is much more heavily weighted to the fourth quarter versus the third quarter.

But like we should see some sequential year-on-year sales improvement in 3Q versus where we were in 2Q?

Modest a little bit in Q3 but most in Q4.

Most in Q4, okay, and then just one, and maybe it's a more follow-up to Rob's question, but if you look at the five largest categories in the US where you fell short, did the competitors do something different than you expected?

So where you were trying to optimize trade spend or there's some instances in these categories where maybe your competition isn't and that's what's causing the shortfall?

So, Brian, thank you for that.

What I would say in general, the operating environment is fairly rational, it is rational.

But in some of our biggest categories, a couple of our biggest categories, we did see an increase in trade promotion in the second quarter.

We saw it a little bit in soup where our lead competitor had a pretty poor fall last year and came back a little stronger, and then we saw a little bit in cereal as well, a little bit more promotional in cereal, and also in refrigerated dough.

So for three of those categories, we saw some more promotional support than we had seen before and that really, in combination, with our pulling back is the part of the challenge we saw in the quarter.

Thank you, everyone.

Have a happy holiday.

Thank you, you too.

Thank you very much.

And we'll get to our next question on the line from Andrew Lazar with Barclays.

Go right ahead.

Good morning, everybody, and happy holidays.

Hi, Andrew.

Good morning.

A bit of a follow on as well and it's a little more philosophical, but how important is the 20% margin target in FY18 specifically?

In light of a top line that was supposed to be showing some modest growth through FY18, I'm just trying to get a sense of having a specific margin target out there.

And I understand what drove the thinking around putting a target out there when you did, but we're in a bit of a different environment now I think.

And does that maybe limit you in what you may feel you need to do from a reinvestment perspective, just to get the top line to stabilize?

Because having a certain margin target, obviously, is nobel in a lot of ways, but if it comes on a significantly smaller sales base, it's still -- it doesn't get you, obviously, to where you want to be.

So it's a little more philosophical, but I was hoping you could take a shot at that.

Well, Andrew, again, I'll start.

It's been, as we look at the environment, which has been slower growth across consumer industries and listen pretty carefully to our investor people who hold our stock, there really has been a very, very high interest in margin in this environment.

And so, we felt it was important to make it clear that we've heard that interest and it was helpful externally.

But I'll also tell you very helpful internally for us to set a very clear and important goal.

I also want to tell you that the actions that we've taken to achieve that have been highly positive for General Mills.

And so, the work that we've done over the last several years to optimize our supply chain, getting the right capacity in the right place, has been extremely beneficial to the Company for the long term.

The base that's there now is very highly utilized, the actions that we've taken, in fact, as we've said a number of times, opened the door to a second wave of productivity initiatives, as those plants are highly utilized.

So that's been extremely positive for General Mills.

And the work we've done on the administrative structure just to get a lighter structure, the work that we just announced to optimize the structure for global growth with our North American segment, the Europe developed marketing segment, Asia, that segment, these are really designed now for executional efficiency, better sharing, they're just way more efficient.

So I understand the question, but I would just say that the work that we've done and that we put in place to achieve these stronger margin goals has, I would say, overall, been very highly positive for General Mills and sets us up very well for the future.

Obviously, margin and free cash flow, very important metrics for us.

We talk about them repeatedly.

Top line, of course, is also super important.

So we understand how important it is to get the top line to term, and we're very focused on that.

If you guys want to add anything?

You have to understand a couple things.

I don't want to reiterate too much what Ken said.

But I think it's important to understand that as we look at our business, there's different levers we can pull to drive shareholder return.

Sales growth is clearly the one that has the longest term benefit and where our focus is, but there's clearly margin expansion, there's cash conversion, and cash return to shareholders.

And at different points in our history, we've pulled those at different strengths based on what the market could bear.

And as we looked at the market over the past couple years and at least for the near term, with less available top-line growth, we wanted to make sure that we were still delivering a competitive return for our shareholders and that meant more on the margin.

So that was one input.

The other is setting a target, and Ken touched on this, it does make you think differently.

And it's brought to bear more ideas in terms of where we can find efficiencies, and we've done it throughout our P&L and our balance sheet.

And as a result, it's creating flex for us to reinvest back in our business.

And I think those are all good things.

But at the end of the day, the goal is to ensure that we are investing behind good top-line-growing ideas and then driving a competitive margin.

And that's really where we -- at the end of the day, those are the two key things that we look at.

Got it, no I appreciate that color, thank you.

And just a very quick one, just the new top-line guidance, what does that embed for what you're expecting for foundation and the growth portfolios?

Before it was, I think, down mid single digit for foundation and up low single digit for growth.

I don't know if you have a new metric on those, thank you.

Yes, we do, thank you, Andy.

As Jeff walked you through, a couple of our large growth businesses is where we were short in the first quarter and the first half.

So as a result, as we look forward today, our growth businesses will probably be a touch negative, low single digits versus the plus low single digits we started the year.

The foundation businesses, actually have held in well and will still be in the range of mid single digits, maybe at the lower end of the range but still in that range.

So that's how you would think about our new sales guidance.

Great, thanks so much.

I would add on to that, Don, that for the US, we're expecting only modest improvements.

The guidance that we've given allows for only modest improvement in the top line in the US, while continuing to expand margins.

As we look at the second half, our two biggest improvements will be in our convenience and Foodservice segment, as well as in Europe.

Thank you.

Thank you very much.

We'll get to our next question on the line from the line of Ken Goldman with JPMorgan.

Hi thanks.

I have two for Don.

One quick one, if I can, and then a longer one.

Don, just to follow-up on a question earlier, in terms of the pacing of the year, tax rate guidance, I think implies roughly 27% for the back half of the year.

As we model, should with model that evenly across both quarters or is there maybe a timing factor that might give a disproportionate benefit to 3Q or 4Q?

The numbers about right for the back half of the year.

I'd have to check the quarterly phasing of it.

I know last year we had a plus in Q3 because of some US tax legislation that came through.

That may push it a little bit more to Q4 as the opportunity, but point out, that I'll have to confirm that for you, Ken.

Okay, yes, no problem.

And then, my longer one is about the free-cash-flow guidance, and bear with me through some math, if you would.

But through the first half of the year, I think your free cash is down over 20% year on year.

I know these things move back and forth and there's timing issues and so forth, and I'm not curious about why things can jump and reverse in the back half.

But it does in employ a pretty sizeable second half, I think over 30% just to get to your guidance.

Which in turn, implies free cash that is about $1.4 billion in the back half, which General Mills has never quite achieved before.

So I'm curious, Don, is there something unique in the back half of the cash story we should be aware of?

You talked about payables.

Is CapEx going to drop?

I'm just trying to understand a little bit more of the drivers behind that if I could.

Yes, it's really good question, I'm glad you asked it.

There's actually three things and they really all resolve around working capital.

The first is a year ago, we had a big payable from the Green Giant sale that hit our operating cash flow, even though the -- obviously, the cash that came out or cash that came in was in the financing section -- or in the investment section, excuse me.

So we had a large liability that will not obviously re-occur this year.

So that was $160 million, I believe, in the -- at this point last year.

So that will change the complexion of our working capital in the balance of the year.

The other is our trade and advertising accruals.

As we've said, our media, our trade was down in first half, even a bit more than we had planned and anticipated.

As we reinvest more in the back half, those accruals will come up, again, favorably impacting working capital.

And then lastly, and the one that's the most sustainable that we'll carry forward into FY18 as well, is our focus on core working capital.

Inventory was a bit higher than we wanted it to be at the end of the second quarter, and that's because volumes did not come in as anticipated.

That will even out and come down as the year unfolds.

And then, most importantly, is we continue to work on our payables and as we move our vendors to 90-day terms, we'll see that benefit start to accrete more in the second half and, again, more in 2018 as well.

So it's all around working capital, and it's those three big items, the tax payable on the Green Giant divestiture a year ago that we're rolling over; the level of the advertising and trade payables that will increase the year goes on as we increase investments in those two areas; and then the core, our continued work on reducing core working capital.

Is it still safe for us to model maybe $730 million, $740 million in CapEx?

I think that was the guidance in the 10-K.

Yes, that's correct.

Great, very helpful.

Thanks, Don.

Thank you very much.

We'll get to our next question on the line with David Palmer from RBC.

Go right ahead.

Thanks, good morning.

First to follow-up on that segmentation approach and the related promotion shifts.

Do you think in some cases, you could have done a better job of analysis ahead of time, such that you could have further minimized the volume fall offs?

Or conversely, should we just realize that this process is going to have some unknowns, that you may have a competitive response here or there and there's going to be lumpiness in terms of net revenue realization, both positive and negative by quarter?

David, look, we did a lot of analysis before embarking on this net revenue management journey.

And the returns that we're seeing from our advertising and our trade are playing out as we expected them to.

What I would say is that the competitive atmospheres dynamic and what you'll see from us is making sure we're making adjustments over those plans as we go along, which is what we're doing in the back half.

So even though we get a lot of things right, some of the things we tactically need to adjust, and that's what you're seeing us do in the back half of this year.

So as time goes on, we're dedicated to it, but I would say that we've analyzed deeply in the second quarter and we've already made some changes, even from the end of our second quarter, which is the end of November until today.

So I think what you'll see from us is making sure that while we remain dedicated strategically to net revenue management and optimizing our profitable volume, we'll make adjustments as time goes along and as we see the competitive dynamics change.

And just small one on weather.

Do you think it played a role in that November quarter?

It was a pretty warm quarter.

Do you think it might have been a drag on the Pillsbury and Progresso brands?

And perhaps with the cold snap we're seeing in December, some of the early signs are better for these platforms?

Well, that may be the case to a small degree in soup and on baking, but I would say that the bigger driver of our performance is always what we do and the spending we put in place and how effective our spending is or our new products are.

And so as we look at the second half of the year, I'm certainly not opposed to it being cold.

But for us, we're really look at what we can drive, which is making sure we make the taxable adjustment to our spending and what we think is a good new product line up for the second half.

Great, thank you.

Thank you very much.

We'll get to our next question on the line from Jason English from Goldman Sachs.

Go right ahead.

Good morning, folks

Good morning, Jason.

Thank you for letting me ask the question.

I've got a couple of them; I'll just rattle them off quickly.

First, on gross margins, can you give us a view of what you're expecting through the full year and also what the slope of input cost inflation looks like for that 2%?

Is it steady throughout the year or is there any ramp or decel to it?

Yes, so our gross margin, we increased 50 basis points year to date.

We think it will be up closer to 200 basis points in the back half of the year.

So at full year we'll be below our original 150 guidance, probably more in the 100 to 120 range, but it will improve in the back half for some substantial reasons.

First off, we'll get better volume leverage.

As we see improved sales in the back half, it's primarily from volume, so our gross margin will benefit from that.

The comps from last year, if you look at our trend last year, our gross margin expansion was essentially all in the first half, and that was due to inflation phasing where inflation accelerated during the course of F-2016.

Last year, gross margins were up 170 basis points in the first half; it was actually about flat in the second half, and actually Q3 was down 130 basis points.

So again, I think that gross margin expansion this year on a comparable basis will skew to Q4.

To your specific question on inflation, we think it's fairly stable through the course of the year, a slight acceleration in the back half in the fourth quarter.

And obviously, we'll see pretty steady contributions from HMM exceeding that inflation.

Our cost actions will build during the course of the year.

That will help gross margin in the back half.

And then transaction FX, which for the full year will be about a $50 million drag for us, but $35 million of that is in the first half, as I said in my comments.

The pound will continue to impact us in the back half, but we think the Canadian dollar will be less so.

So we've absorbed the majority of the transaction FX negative in first half, so that will be less of a drag in the second.

So really those four things, the volume leverage that we'll get in the second half slightly better than the first half; the comps, particularly around inflation phasing will favor the back half this year again, especially the fourth quarter; our cost actions will build around Project Century benefits; and then transaction FX, still a negative but a lighter negative in the back half.

That's helpful, 125 BPs for the full year still sounds pretty solid even if it's a bit below 150.

Building on that, to get to your 150 full-year EBIT margin expansion, A&P's adding -- on track to add around 100 BPs to margins, and maybe you spend some back, let's just say it adds 75.

So between GM and A&P, you'll have 200 BPs of margin cushion there, implying some SG&A leakage at margin despite all of the aggressive cost cuts.

Is that just a product some of the sales softness?

Is it a cadence of the SG&A discipline?

I don't know, maybe you could shed some light on that.

Yes, I'm not following all your math on that, but from an advertising standpoint in the back half of the year, we said in the last call we expect advertising after the first quarter to be down double digits for the year.

We still believe that, probably mid-teens, which means it will be better in the back half, still down slightly.

But importantly, up in some key businesses.

Matter of fact, if you look at our growth businesses in the back half, excluding US yogurt, which we've always said, we're going to really right size our investment there given our historical share of voice, excluding US yogurt, our growth businesses, advertising investment, media investment will be up low single-digits in the back half.

Again, it's fairly spread across the businesses that Jeff talked to.

So we'll see that in the back half.

And then actually, our admin continues to be below last year, both at -- within SOP and then in corporate level as well, so that's actually a contributor.

Obviously what's different is that sales are lower and volume is lower than we started the year, and that's an offset.

So again, I didn't exactly follow your math, but we expect to get our 150 basis points of operating margin expansion.

We'll get a good piece of that, as you noted, through gross margin, and we will get the balance through the rest of the P&L.

But all lines, including administrative costs and overhead costs, will contribute.

Okay, very good, thank you.

Thank you very much.

We'll get to our next question on the line from Chris Growe with Stifel Nicolaus.

Go right ahead.

Hi, good morning.

Good morning, Chris.

Hi, just had a couple questions for you.

The first is without getting to like future revenue growth guidance, and I think there was a question that alluded to this earlier, just that you do expect your revenue growth to improve in FY18.

Is that degree of improvement changing such that you're relying more heavily on cost savings to achieve the operating margin target?

As I see the revenue growth weaker in this quarter but also weaker for the year, was worried that some of that could carry into FY18 and just could lead to a little more challenge in achieving the operating margin.

I think, hi, Chris.

I think that first of all, we'll -- we don't want to give guidance for FY18 in December.

But to your point, the way this year is coming out, I think we'll have to look at all of the components of next year.

I think this year coming in softer is obviously going to have to play in to how we look at next year.

We think that the second half will be, as we've said, better and will build momentum through Q3 and Q4.

And so we expect to enter 2018 with the top line going in a better direction.

Obviously, we've talked in great detail about all of the margin work that will continue to play out as we go into FY18.

So I think that your point about entering FY18 at a lower level than you expected, of course has to be considered and we'll give detailed guidance on all of that in June as we always do.

Okay, and then just a question for you on the international growth in sales and operating profit, it was a little weaker than I thought this quarter.

So I want to understand just how the -- or maybe what regions the performance is expected to improve.

And then just understand, like when you talk about marketing and that being down in the first half of the year, is international going to see a heavier marketing investment in the second half as well that could weigh on the margin a bit?

So, Chris, thanks for that question.

As we look at the second half of the year, the biggest improvement we'll see will be in Europe, and this is a very profitable business for us in that we improve that business in the second quarter from the first quarter.

We had a tough summer based on Haagen-Dazs sales, as well as the Yoplait integration.

But we still have the second quarter to improve on Haagen-Dazs, and as well as OEP, Old El Paso, and bars and we expect that to continue in the second half of the year.

We've got really good innovation on Haagen-Dazs, good innovation on Old El Paso, and we continue to expand our bars business.

So, and the integration of our Yoplait business with our European business will be largely behind us.

So we expect improved performance from there.

So I would say in the second half you'll see that.

But I also want to mention that what we see is our two largest developing markets, China and Brazil, have returned to growth if you look at organic growth.

They're somehow -- they're a little bit clouded by some restructuring we're doing of our Snacks business in China and of our acquisition of yogurt in Brazil.

But underlying that, in China, we're back to mid single-digit organic growth.

We're growing on our Wanchai Ferry business, we're growing Haagen-Dazs, and we continue to see good growth from yogurt.

And we're back to growth in Brazil as well, and we're executing better in Brazil and so we're back to growth there.

So as we look at the second half, we expect to see growth from our two biggest developing markets, as well as improved performance from Europe.

Just the only thing, maybe Chris, or the only thing to add just as a point is also that both of our joint ventures are performing pretty well.

Haagen-Dazs Japan had a good quarter, and I think importantly, we now have, I think two and maybe three quarters of improved performance in CPW, really with performance across-the-board better in that joint venture.

So internationally, we're also seeing improving contribution from those JVs.

Okay, thanks very much.

I appreciate it and happy holidays to you.

Thanks, Chris.

Operator, I think we've let everyone take two bites of the apple with questions.

We probably have time for one more, maybe a second.

But let's go for one more.

Certainly.

We'll get to one more question on the line from Steven Strycula from UBS.

Hi, good morning, guys.

I have a two-part question.

The first part would be just a recap.

What would you say is the key explanatory reason as the revised guidance on sales?

Is it, looking back to how you guided in July, is it more the delta that we're seeing in the yogurt business?

Or was it a little bit of a surprise in meals just expected that the core US retail trends would improve, but it's cleaner aisle impact in major retailers?

That's one.

And then the second question would be what is your go-forward M&A strategy given that the US markets have been decelerating a little bit more recently and emerging markets remain volatile?

This is Jeff Harmening.

Let me take the first part of that question, then I'll hand it over to Ken for the second part.

On the first piece, on the first half of the year, we plan to take out unprofitable volume, and we talked about that, and we certainly did that while improving our margins.

But the combination of taking out a little bit more spending than we had anticipated, as well as the competitive environment being a little bit more promotional than we anticipated, that combination is what led to our first-half sales results, particularly in the US, being below what we expected them to be.

And although we got it right in some places on our spending, in some place we need to make adjustments.

And on the M&A front, look, as we've said, we continue to look, in many places, for opportunities to create value and these would be acquisitions that could drive growth or synergy or both.

We would look both in the US and internationally.

We are quite interested in snackable ideas.

Snacking is very much on trend, and also simplicity and natural is of interest to us.

Bolt-ons to existing business are quite interesting to us.

So if you look at the last 24 to 30 months, we acquired Annie's, an organic business; Epic Provisions, all--natural beef snacks; Carolina Yogurt, a bolt-on.

And so those are the kinds of things we've been doing.

We continue to look in those areas.

Okay, great, and then one follow-up for Don.

Just to make sure that I heard you correctly, for the year-over-year earnings growth rate in the back half, fourth quarter supposed to be more pronounced growth than the third quarter if I heard you correctly, is that accurate?

That is correct.

Okay.

Thanks guys, happy holidays.

Do we have time for one more if we can sneak on?

Absolutely, we'll take one more question on the line from the line of David Driscoll from Citi.

Go right ahead.

Man, that must have been my holiday Christmas present.

Thank you and good morning.

I really appreciate that, and I think that's a couple of good ones here.

I wanted to ask about the volumes in US RO.

So it's down 10, and wanted to understand how much of this is unprofitable volume that, frankly, you don't mind jettisoning, versus good stuff you're really disappointed to see go?

So could we start there?

Well, David, this is Jeff.

I would say, look, a large part of it is unprofitable volume, and that's why our US -- despite the fact that you can imagine we had a lot of deleverage, given that our volumes were down 10% in the quarter, why our operating margin was up 270 basis points.

Because, and it's not the only reason, but for sure, a lot of this was unprofitable volume that we don't mind, we don't mind losing.

I think there were a couple cases where we felt like we had, we feel like we have good marketing, good news and some things we could optimize.

And I look at cereal advertising, for example.

We love the returns we get from our gluten-free advertising and from no artificial colors and flavors.

And that advertising, we think we can spend more than we did in the second quarter, because we like the returns on that and we think we have really good news.

And then bigger picture, the hills guidance is down 2 to 3 points, the segment profit guidance is down 4 points, so it goes back so this unprofitable volume question.

When I looked at figures like that on the reduction, it sounds to me like the sales that you're now expecting, this change in sales guidance, this was good stuff.

This was volume that you did not want to lose, yet you are.

So it does seem as if, if I'm reading all of the tea leaves here correctly, that we're getting into some of the bone here rather than just taking out [sign of] excess fat, ie, unprofitable volume.

Is that the right way to characterize what's happened within the sales guidance change?

Well, David, as I would say, as I said, looked like there's a large portion of the volume that was not particularly profitable and we got rid of that.

But I also said that we didn't get it exactly right.

And so I think there are some pieces of that volume that are more profitable, especially the non-promoted volume on big brands like cereal and like bars, where we think we didn't get the spending exactly right.

And by spending more to improve the every day sales of those businesses, we can drive both our volume and our profitability.

Yes, David, this is Don.

The only other thing I'd add in terms of, if you look at how much we reduced our sales guidance buy versus SOP, the other factor not to lose sight of that doesn't impact sales, is our transaction FX.

Not to mention, we have a $50 million, roughly $50 million negative transaction for products shipped into Canada and into the UK.

And about 40 of that, frankly was -- it's about $40 million higher than what we had planned, because obviously, the Brexit happened after we announced our guidance.

And that's incorporated into these updated guidance figures as well.

Final question for me.

Ken, with the sales guidance reductions, you still are very confident on the call about the 20% margin goal in 2018.

And would you simply characterize that the change in sales here is just not so significant relative to this 20% goal, that investors need to be concerned about the achievement of the 20% goal in light of the sales performance?

Look, we want to do all three.

Our core metrics, our revenue growth, margin expansion, and the efficiency with which we generate free cash flow and return it to shareholders.

So all of us, all of those are, we think, are very important to our investors and we're very focused on all three.

Clearly, over the last several years, we've been highly focused on a variety of very positive restructuring initiatives just in terms of increasing the efficiency of our business model.

That's all been very good, and that's included eliminating some volume that was unprofitable.

I think as we go forward and with the distraction in some of those things mostly behind us, we're very highly focused on generating top-line growth.

Obviously that's critical to sustaining our business model and we're very focused on that.

That will be very important and we'll see things improve here in the second half, and we'll be highly focused on continuing that momentum as we go into FY18.

Thanks so much and happy holidays.

Thank, everyone, for sticking with us.

I know we didn't get to everybody, so I'll be on the phone all day> Please give me a ring.

I look forward to speaking with you.

Happy holidays, everyone.

Thank you very much.

Ladies and gentlemen, this concludes the conference call for today.

We thank you for your participation and ask that you disconnect your lines.

Have a good day, everyone.